How Long Will US Debt Remain the Destination of Choice for Global Capital?

Mitch McConnell is apparently promising that last week's histrionics over the debt ceiling were merely a prelude to a lengthy drama in which we re-enact this battle every time the debt ceiling needs to be raised.

"What we have done, Larry, also is set a new template. In the future, any president, this one or another one, when they request us to raise the debt ceiling it will not be clean anymore. This is just the first step. This, we anticipate, will take us into 2013. Whoever the new president is, is probably going to be asking us to raise the debt ceiling again. Then we will go through the process again and see what we can continue to achieve in connection with these debt ceiling requests of presidents to get our financial house in order."

Just how bad you think this is depends on how unlikely (or undesirable) you think it is that we will ever again run a surplus.  But even an optimist would have to admit that it's pretty bad.  As Karl Smith says, "This is the type of thing that should encourage banks and governments around the world to intensify the search for an alternative to the dollar and US Treasuries."

The real question is: why hasn't it already?  And the answer, as Karl suggests, is "Where the hell else are investors going to go?"  The US dominates the market for AAA securities.


There is simply no other market that makes a plausible substitute for US securities.  China is big enough, but its capital markets are primitive, and subject to heavy government intervention.  Japan has lost its AAA, and has a massive debt overhang, to boot.  None of the other AAA countries--or even all of them together--are big enough, and debt-hungry enough, to absorb the amount of capital flowing into the United States.

Ultimately, some of the world's investors are going to have to wean themselves off of the illusory security of AAA debt, because obviously, we cannot keep issuing a trillion worth of AAA debt every year.  Either we'll issue less debt, or we'll lose our AAA.

The good news is that slowing down our issuance will raise the premium paid for the AAA that's left.  So as we start putting our finances back in order, we'll enjoy lower interest rates that will help us do it. There aren't many virtuous cycles left in the world, it seems, so that's something to be happy about.